And Zaccheus stood, and said unto the Lord; Behold, Lord, the half of my goods I give to the poor; and if I have taken any thing from any man by false accusation I restore him fourfold.

Geneva Bible, 1602 edition, note on Luke 19:8

for commonly they [tax collectors] have this trade among them when they rove and spoil the people, they have nothing in their mouths but the profit of the people, and under that color they play the thieves in so much that if men reprove and go about to redress their robbery and spoiling, they cry out, the people are hindered. [Note: the words "Commonwealth" and "Commonweal" are translated "people," conforming them to modern usage, agreeable with Black's Law Dictionary.]

In January 1998 the U.S. Tax Court upheld the IRS' retroactive (to 1984) revocation of United Cancer Council, Inc.'s ("UCC") tax-exempt status. However, in one of the most important nonprofit tax developments of the decade, this decision was reversed by the United States Court of Appeals for the Seventh Circuit in February 1999.

The Seventh Circuit rejected the IRS' retroactive revocation of UCC's tax-exempt status (UCC was tax-exempt under IRC sec. 501(c)(3)), based on an unprecedented, attempted IRS expansion of the tax code's prohibition against "inurement"(or improper benefit to those who run the nonprofit organization).

United Cancer Council, Inc. was organized as a non-profit corporation in 1963. Its tax-exempt status under section 501(c)(3) of the Internal Revenue Code was recognized by the IRS in 1969. Until 1984, UCC was supported primarily by affiliate member agencies, but also engaged in some direct solicitation of individuals. Its annual budget never exceeded $50,000.

When a budget crisis developed in 1983, UCC's board sought a professional fundraiser to assist it in conducting fundraising without requiring any initial capital expenditure by UCC. UCC's board of directors (30 members, including two judges) negotiated with the Watson & Hughey firm ("W&H") for six months, then formally reviewed and approved the contract. W&H agreed both to provide the initial capital to conduct the fundraising campaign and to furnish funds to permit UCC to continue to operate. Additionally, if the funds raised were not sufficient to cover the fundraising expenses, W&H agreed to pay the excess. The contract was similar to contracts which have been signed by many other tax-exempt organizations in the past.

In 1985, the first full year of the contract, UCC received $168,000. By January 1987, UCC received $50,000 a month, its maximum annual income before the contract had been signed. The contract lasted for five years, and expired by its terms in June 1989. UCC netted $2.25 million from the contract, and had $500,000 in the bank and no fundraising debts when the contract ended. The IRS revoked UCC's tax-exempt status -- retroactive to the date when UCC contracted with W&H -- in November 1990, more than one year after the contract with W&H had expired.

The Seventh Circuit attacked the IRS' argument in this case as making "the tax status of charitable organizations and their donors a matter of the whim of the IRS." The Court observed that "[i]t is hard enough for new, small, weak, or marginal charities to survive, because they are likely to have a high expense ratio, and many potential donors will be put off by that. The Tax Court's decision, if sustained, would make the survival of such charities even more dubious, by enveloping them in doubt about their tax exemption." The Court recognized that the inurement provisions in federal tax law are "designed to prevent the siphoning of charitable receipts to insiders of the charity, not to empower the IRS to monitor the terms of arm's length contracts made by charitable organizations with the firms that supply them with essential inputs, whether premises, paper, computers, legal advice, or fundraising services."

The IRS has sought to characterize an exempt organization's income from an affinity credit card program operated by a bank as subject to the tax on unrelated business income subject to unrelated business income tax (UBIT). IRS Exempt Organizations Division Director Marcus S. Owens has stated that the IRS is not likely to litigate the affinity credit card issue again.

This decision follows a series of defeats suffered by the IRS on this issue, including Oregon State University Alumni Association, Inc. v. Commissioner and Alumni Association of the University of Oregon, Inc. v. Commissioner, both decided by the United States Court of Appeals for the Ninth Circuit on October 4, 1999, and Mississippi State University Alumni, Inc. v. Commissioner, T.C. Memorandum 1997-397. In each case, the Tax Court used now-familiar reasoning to reject the Service's argument that income from affinity credit card income should be taxable.

The IRS has also suffered a series of defeats this year in its efforts to characterize mailing list income as subject to UBIT: Common Cause v. Commissioner, 112 T.C. No. 23 and Planned Parenthood Federation of America Inc. v. Commissioner, T.C. Memorandum 1999-206, both decided on June 22, 1999, as well as Sierra Club, Inc. v. Commissioner, T.C. Memorandum 1999-86 (on remand from the U.S. Court of Appeals for the Ninth Circuit).

AUTOMOBILE DONATION PROGRAMS

The IRS is targeting automobile donation programs, warning that such programs in which charities encourage taxpayers to donate used vehicles in return for a charitable contribution deduction, may run afoul of several tax code requirements. In Chapter T of its latest Continuing Professional Education (CPE) text for exempt organizations, the Service alerts its agents concerning problems with used car donation programs. The Service's focus is on exempt organizations that allow third-party entrepreneurs to use their names to solicit contributions of cars.

According to the IRS, some programs promise to give contributors a "full blue book value" deduction, even where the vehicle does not have such value. Other programs, a charity allows a used-car dealer to use the charity's name to solicit donations; in return, the charity receives an annual fee that is not tied to the number, condition, or value of the vehicles donated.

DISCLOSURE STANDARDS

The IRS issued regulations establishing new rules for public disclosure of IRS Forms 990 (annual information returns) and exemption applications (IRS Form 1023 and 1024). The final regulations provide guidance on (1) the place and time an organization must make documents available for public inspection, (2) conditions the organization may place on requests for copies, and (3) the amount, form and time of payment of any fees an organization may charge.

Earlier, the IRS determined that it would not increase the annual revenue threshold determining which nonprofits must file a Form 990. Currently, nonprofits with annual "normally" revenues at or above $25,000 a year generally must file a Form 990 with the IRS each year.

The IRS had solicited comments on a proposal to increase the threshold to $40,000 or higher, noting that the threshold had not increased since 1982. However, opposition from state attorneys general and other bureaucrats led the IRS to drop the proposal.

INTERMEDIATE SANCTIONS AND INUREMENT DECISIONS TO BE MADE BY IRS NATIONAL OFFICE

IRS field agents are required to submit issues regarding Code Section 4958 intermediate sanctions, as well as private inurement under Code Section 501(c)(3) or 501(c)(4) to the National Office for technical advice prior to making any independent decisions. Chapter B of the Service's CPE Text identifies four types of fact patterns in which technical advice must be requested by field agents:

1. Cases in which a Section 4958 tax is proposed;

2. Cases in which adverse action on a private inurement issue is proposed;

3. Section 4958 excess benefit transaction cases being considered for resolution by closing agreements; and

4. Private inurement cases being considered for resolution by closing agreement.

In cases involving excise taxes under Section 4958, separate technical advice requests must be submitted for each exempt organization and each disqualified person who participated in an excess benefit transaction because of potential conflicts of interest among the parties. IRS National Office involvement is required because final regulations under Section 4958 have not yet been issued.

6. AMERICAN TARGET ADVERTISING V. GIANICASE NO. 98-4158 (PENDING BEFORE THE U.S. COURT OF APPEALS FOR THE 10TH CIRCUIT)

Another recent case (not involving the IRS, but challenging the Utah charitable solicitations statute) is American Target Advertising (ATA) v. Giani. This case arose when a 501(c)(3) nonprofit located in Washington, D.C. retained ATA, a Virginia corporation, to assist it in preparing nationwide mailings. When the nonprofit attempted to register with the State of Utah, Francine A. Giani, who directs the office enforcing the Utah Charitable Solicitations Act, demanded that ATA also register with the State before the nonprofit could mail into Utah.

ATA refused to register with the State of Utah for these and other reasons:

ATA is located in Virginia, not Utah;

ATA has no office or personnel in Utah;

ATA does not mail into the State of Utah;

ATA has no contact with the State of Utah; and

ATA does no business with anyone in the State of Utah.

In response to ATA, Giani denied the nonprofit's registration, and would not allow it to mail into the state until ATA registered with her office, the Division of Consumer Protection (the "Division"). Later, the Division granted the nonprofit a license, but required it to agree not to correspond with Utah residents using any materials that ATA helped develop or conduct any

fund-raising based on ATA's advice and consultation.

ATA sued Giani and the State of Utah for violating its constitutional rights, and those of its client. ATA argued that the Utah Act is unconstitutional, violating the First Amendment, Due Process of Law guaranteed by the 14th Amendment, and the Commerce Clause.

The U.S. District Court for the District of Utah upheld Utah's registration requirements, and ATA has appealed the case to the U.S. Court of Appeals for the 10th Circuit. Oral argument has been held, and a ruling on the appeal is anticipated next year.

POLITICALLY-MOTIVATED AUDITS OF NONPROFITS

In 1997, the Joint Committee on Taxation (made up of U.S. Representatives and Senators) initiated an investigation into politically-motivated audits of nonprofits conducted by the IRS. The committee began by requesting certain documents from the IRS, but the IRS was said that it was not able to find many of the documents requested. (A whistleblower declared that the documents had been shredded by the IRS.) The committee has since requested interviews with various witnesses. However, in view of reports that Representatives and Senators from both political parties engage in this practice, no substantial limitations on this practice are anticipated to result from this investigation.

LOBBYING: PROXY TAX

P.L. 103-66, the Revenue Reconciliation Act of 1993, established the "special rules relating to lobbying activities," found at Internal Revenue Code ("IRC") § 6033(e). The proxy tax does not apply to 501(c)(3)s, or to other nonprofits making only in-house lobbying expenditures(1) of $2,000 or less. IRC § 6033(e)(1)(B).

P.L. 104-188, the Small Business Job Protection Act of 1996, clarified that the provisions of IRC § 6033(e) shall not apply to any amount which is taxed under IRC § 527(f)(2).

Of all the nonprofits which are tax-exempt under IRC § 501(a), only 501(c)(4)s (excluding veterans organizations), 501(c)(5) agricultural and horticultural associations, and 501(c)(6) trade associations are subject to either the notice/reporting requirements or the proxy tax imposed by IRC § 6033(e). Rev. Proc. 95-35. However, these 501(c)(4)s and (c)(5)s can also avoid the notice/reporting requirements if more than 90 percent of all annual dues are either received from: (1) persons, families, or entities paying annual dues of $55 or less; or (2) 501(c)(3)s, state governments, local governments, entities which are tax-exempt under IRC § 115, or the nonprofits which are tax-exempt under § 501(a), described above. Rev. Procs. 95-35, 97-57 (setting standard at $55 or less for 1998). Further, 501(c)(6)s can avoid the reporting requirements if more than 90 percent of all annual dues are received from 501(c)(3)s, state governments, local governments, entities which are tax-exempt under IRC § 115, or the nonprofits which are tax-exempt under IRC § 501(a), described above. Rev. Proc. 95-35.

Additionally, a nonprofit which is otherwise subject to the proxy tax requirements can obtain exemption from the requirements by maintaining records establishing that 90 percent or more of the annual dues (or similar amounts) paid to the organization are not deductible without regard to section 162(e) and either: (1) notify the Service that it is described in section 6033(e)(3) on any Form 990 that it is required to file; or (2) request a private letter ruling that substantially all the annual dues (or similar amounts) paid to the organization are not deductible, either directly or indirectly, without regard to section 162(e). Rev. Proc. 95-35.

The IRC § 6033(e) notice/reporting requirements are as follows: "the nonprofit shall include on any return required to be filed under [IRC § 6033(a)] for such year information setting forth the total expenditures of the organization to which [IRC] § 162(e)(1) applies and the total amount of the dues or other similar amounts paid to the organization to which such expenditures are allocable, and (ii) except as provided in [IRC § 6033(e)(2)(A)(i) and (3)], shall, at the time of assessment or payment of such dues or other similar amounts, provide notice to each person making such payment which contains a reasonable estimate of the portion of such dues or other similar amounts to which such expenditures are so allocable." Under § 6033(e)(2)(A)(i), a nonprofit may elect not to provide the notice described above for any taxable year; however, it must then pay a proxy tax calculated at the highest corporate income tax rate (currently 35 percent) on "the aggregate amount not included in such notices by reason of such election or failure." See also 1998 IRS Form 990-T (Exempt Organization Business Tax Return), Instructions, p. 12.

The proxy tax may be waived by the IRS, if the organization agrees to adjust the estimates contained in its notices for the following tax year -- "to correct any failures." IRC § 6033(e)(2)(B). The IRS may also require the calculation of proxy tax be reflected in any payment of estimated tax: IRC § 6033(e)(2)(C) states that the proxy tax "shall be treated in the same manner" as income taxes.

INTERMEDIATE SANCTIONS

IRC section 4958 was enacted as part of the Taxpayer Bill of Rights 2, which was signed by President Clinton on July 30, 1996. IRC section 4958 creates three levels of excise tax for "excess benefit" transactions by organizations described at IRC sections 501(c)(3) and 501(c)(4): the section 4958(a)(1) excise tax, the section 4958(b) excise tax, and the section 4958(a)(2) excise tax. They are commonly referred to as "intermediate sanctions" because they allow the IRS to choose to impose financial penalties (rather than, or along with, revocation of tax-exempt status) for excess benefit transactions (i.e., those unreasonably benefitting "disqualified persons").. Previously the IRS was limited to revocation of tax-exempt status for minor offenses, which it says it tried to avoid.

On July 30, 1998, the IRS issued a Notice of Proposed Rulemaking, setting out proposed regulations implementing IRC section 4958. A hearing before the IRS was held to solicit input on these regulations. These regulations have not been issued in final form.

Section 4958 taxes apply retroactively to transactions occurring on or after September 14, 1995, except for transactions occurring pursuant to a written contract that was binding on September 13, 1995, and at all times thereafter before the transaction occurs. However, a contract that is terminable or subject to cancellation by the applicable tax-exempt organization without the disqualified person's consent is treated as a new contract as of the date that any such termination or cancellation, if made, would be effective. Additionally, a materially-modified contract is treated as a new contract.

In the following analysis, discussion of the proposed regulations is organized into discussions of each respective excise tax, followed by a discussion of revenue-sharing transactions and revocation of tax-exempt status.

A. The Section 4958(a)(1) Excise Tax

This tax is to be paid by a disqualified person who receives an excess benefit from an excess benefit transaction with an applicable tax-exempt organization. The amount of the tax is equal to 25 percent of the excess benefit received. The tax applies to each excess benefit transaction. With respect to any excess benefit transaction, if more than one disqualified person is liable for the tax imposed by section 4958(a)(1), all such persons are jointly and severally liable for that tax.

"Disqualified Person"

Section 53.4958-3 defines disqualified person as a person who was in a position to exercise substantial influence over the affairs of the organization at any time currently or during a lookback period. This finding is to be based on all relevant facts and circumstances.

Persons having substantial influence include individuals serving on the governing body of the organization; presidents, chief executive officers, chief operating officers, or other individuals, regardless of title, who have or share ultimate responsibility for implementing the decisions of the governing body or supervising the management, administration, or operation of the applicable organization; and treasurers, chief financial officers, or other individuals, regardless of title, who have or share ultimate responsibility for managing the organization's financial assets and have or share authority to sign drafts or direct the signing of drafts, or authorize electronic transfer of funds, from organization bank accounts.

Also, a member of the family of a person having substantial influence is a disqualified person. A person's family includes a spouse, brothers or sisters (by whole or half blood), spouses of brothers or sisters (by whole or half blood), ancestors, children, grandchildren, great grandchildren, and spouses of children, grandchildren, and great grandchildren.

A person is deemed not to be in a position to exercise substantial influence over the affairs of an applicable tax-exempt organization if that person is another 501(c)(3) organization; or an employee who receives economic benefits from the organization that are less than the compensation referenced for a highly compensated employee at IRC section 414(q)(1)(B)(i) (over $80,000), and is not on the governing body, a president, or a treasurer, and is not a substantial contributor to the organization within the meaning of section 507(d)(2) (i.e., contribute more than $5,000 where such amount is more than 2 percent of the total contributions).

Facts and circumstances tending to show that a person has substantial influence over the affairs of an organization include: founding the organization, being a substantial contributor (within the meaning of section 507(d)(2)), receiving compensation based on revenues derived from activities of the organization that the person controls, authority to control or determine a

significant portion of the organization's capital expenditures, operating budget, or compensation for employees, managerial authority or service as a key advisor to a person with managerial authority, or a controlling interest in a corporation, partnership, or trust that is a disqualified person. A person who has managerial control over a discrete segment of an organization may be in a position to exercise substantial influence over the affairs of the entire organization.

Facts and circumstances tending to show that a person lacks substantial influence over the affairs of an organization include: a bona fide vow of poverty as an employee, agent, or on behalf of a religious organization, action as an independent contractor, such as an attorney, accountant, or investment manager or advisor (unless the person might economically benefit from the transaction either directly or indirectly (aside from fees received for the professional services rendered)), and any preferential treatment received based on the size of a donation is also offered to any other donor making a comparable contribution as part of a solicitation intended to attract a substantial number of contributions.

"Excess Benefit"

Excess benefit is generally defined as the value of the economic benefit provided by an applicable tax-exempt organization directly or indirectly to or for the use of any disqualified person that exceeds the value of the consideration (including the performance of services) received by the organization. However, a revenue-sharing transaction may result in an excess benefit regardless of whether the economic benefit provided to the disqualified person exceeds the fair market value of the consideration provided. See "excess benefit transaction," infra.

Section 53.4958-1(e) states that, except as otherwise provided, an excess benefit transaction occurs when the disqualified person receives the economic benefit from the applicable tax-exempt organization for federal income tax purposes. Payment of deferred compensation occurs when the compensation is earned and vested.

"Excess Benefit Transaction"

Section 53.4958-4 defines an excess benefit transaction as a transaction in which an applicable tax-exempt organization provides an economic benefit to or for a disqualified person, where the value of the economic benefit provided exceeds the value of the consideration received. However, a revenue-sharing transaction may constitute an excess benefit transaction regardless of whether the economic benefit provided to the disqualified person exceeds the fair market value of the consideration provided in return if it permits a disqualified person to receive additional compensation without providing proportional benefits that contribute to the organization's accomplishment of its exempt purpose.

Additionally, certain economic benefits will be disregarded for purposes of section 4958:

Payment of reasonable expenses for members of the governing body of an applicable tax-exempt organization to attend meetings of the governing body -- however, reasonable expenses do not include luxury travel or spousal travel;

Economic benefits provided to a disqualified person received solely as a member of, or volunteer for, the organization are disregarded if the benefit is provided to members of the public in exchange for a membership fee of $75 or less per year; and

Economic benefits provided to a disqualified person received solely as a member of a charitable class that the applicable tax-exempt organization intends to benefit as part of the accomplishment of its exempt purpose.

Payment of a premium for an insurance policy providing liability insurance to a disqualified person for the taxes imposed under this section or indemnification of a disqualified person for such taxes by an applicable tax-exempt organization will not constitute an excess benefit transaction for purposes of section 4958 if the premium or the indemnification is treated as compensation to the disqualified person when paid, and the total compensation paid to the disqualified person is reasonable.

An excess benefit may be provided indirectly through the use of one or more entities controlled by or affiliated with the applicable tax-exempt organization. For example, if an applicable tax-exempt organization causes its taxable subsidiary to pay excessive compensation to, or engage in a transaction at other than fair market value with, a disqualified person of the parent organization, the payment of the compensation or the transfer of property is an excess benefit transaction.

An economic benefit shall not be treated as consideration for the performance of services unless the organization providing the benefit clearly indicates its intent to treat the benefit as compensation when the benefit is paid. Such intent is established only if the organization provides clear and convincing evidence that it intended the economic benefit to be compensation. Such clear and convincing evidence includes a report to the IRS of the economic benefit (e.g., Form W-2, 990, 1040, 1099), by either the disqualified person -- or by the nonprofit, if the report is made before the commencement of an IRS examination questioning the reporting of the benefit. Furthermore, if an organization's failure to report an economic benefit as required under the IRC is due to reasonable cause, then the organization will be treated as having provided clear and convincing evidence of the requisite intent. Reasonable cause may be shown by establishing the existence of significant mitigating factors with respect to its failure to report, or the failure arose from events beyond the organization's control, and that the organization acted in a responsible manner both before and after the failure occurred. An organization may use methods other than those described to provide clear and convincing evidence of its intent.

If an organization fails to provide clear and convincing evidence that it intended to provide an economic benefit as compensation for services when paid, any services provided by the disqualified person will not be treated as provided in consideration for the economic benefit.

Presumption of Reasonableness

Payments under a compensation arrangement between an organization and a disqualified person shall be presumed reasonable, and a transfer of property, right to use property, or any other benefit or privilege between an applicable tax-exempt organization and a disqualified person shall be presumed to be at fair market value, if: (1) the compensation arrangement or terms of transfer are approved by the organization's governing body or a committee of the governing body composed entirely of individuals who do not have a conflict of interest with respect to the arrangement or transaction; (2) the governing body or committee obtained and relied upon appropriate comparability data before making its determination; and (3) the governing body or committee adequately documented the basis for its determination concurrently with making that determination.

A governing body committee may include any individuals permitted under state law, and may act on behalf of the governing body to the extent permitted by state law. However, if the rebuttable presumption arises as the result of actions taken by a committee, any members of such a committee who are not members of the governing body are deemed to be organization

managers for purposes of the tax imposed by section 4958(a)(2).

A member of the governing body, or committee thereof, does not have a conflict of interest with respect to a compensation arrangement or transaction if the member: (1) is not the disqualified person and is not related to any disqualified person participating in or economically benefitting from the compensation arrangement or transaction; (2) is not in an employment relationship subject to the direction or control of any disqualified person participating in or economically benefitting from the compensation arrangement or transaction; (3) is not receiving compensation or other payments subject to approval by any disqualified person participating in or economically benefitting from the compensation arrangement or transaction; (4) has no material financial interest affected by the compensation arrangement or transaction; and (5) does not approve a transaction providing economic benefits to any disqualified person participating in the compensation arrangement or transaction, who in turn has approved or will approve a transaction providing economic benefits to the member.

A governing body or committee has appropriate comparability data if, given the knowledge and expertise of its members, it has sufficient information to determine whether a compensation arrangement will pay reasonable compensation or a transaction will be for fair market value. Relevant information includes, but is not limited to, compensation levels paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions; the availability of similar services in the geographic area of the applicable tax-exempt organization; independent compensation surveys compiled by independent firms; actual written offers from similar institutions competing for the services of the disqualified person; and independent appraisals of the value of property that the applicable organization intends to purchase from, or sell or provide to, the disqualified person.

For organizations with annual gross receipts of less than $1 million reviewing compensation arrangements, the governing body or committee will be considered to have appropriate comparability data if it has data on compensation paid by five comparable organizations in the same or similar communities for similar services. No inference is intended with respect to whether circumstances falling outside this safe harbor will meet the requirement with respect to the collection of appropriate data.

Adequate documentation means that the written or electronic records of the governing body or committee must note: (1) the terms of the transaction that was approved and the date it was approved; (2) the members of the governing body or committee who were present during debate on the transaction or arrangement that was approved and those who voted on it; (3) the comparability data obtained and relied upon by the committee and how the data was obtained; and (4) the actions taken with respect to consideration of the transaction by anyone who is otherwise a member of the governing body or committee but who had a conflict of interest with respect to the transaction or arrangement. If the approved compensation for a specific arrangement or fair market value in a specific transaction is higher or lower than the range of comparable data obtained, the governing body or committee must record the basis for its determination. For a decision to be documented concurrently, records must be prepared by the next meeting of the governing body or committee occurring after the final action or actions of the governing body or committee are taken. Records must be reviewed and approved by the governing body or committee as reasonable, accurate and complete within a reasonable time period thereafter.

The fact that a transaction between an applicable tax-exempt organization and a disqualified person is not subject to the presumption described in this section shall not create any inference that the transaction is an excess benefit transaction. Neither shall the fact that a transaction qualifies for the presumption exempt or relieve any person from compliance with any law imposing any obligation, duty, responsibility, or other standard of conduct with respect to the operation or administration of any applicable tax-exempt organization.

The presumption may be rebutted by additional information showing that the compensation was not reasonable or that the transfer was not at fair market value.

Section 53.4958-4(b)(3) defines reasonable compensation as the amount ordinarily paid for like services by like enterprises under like circumstances. Generally, the circumstances to be taken into consideration are those existing at the date when the contract for services was made. However, where reasonableness of compensation cannot be determined based on circumstances existing at the date when the contract for services was made, then that determination is made based on all facts and circumstances, up to and including circumstances as of the date of payment. In no event shall circumstances existing at the date when the contract is questioned be considered in making a determination of the reasonableness of compensation. The fact that a State or local legislative body or agency or court has authorized or approved a particular compensation package paid to a disqualified person is not determinative of the reasonableness of compensation paid for purposes of section 4958 excise taxes.

"Applicable Tax-exempt Organization"

Section 53.4958-2 defines an applicable tax-exempt organization as an organization described in section 501(c)(3) or (4) as exempt from tax under section 501(a) at any time during a five-year period ending on the date of an excess benefit transaction (the Lookback Period). However, where a transaction occurs before September 14, 2000, the lookback period begins on September 14, 1995.

"Lookback Period"

See "applicable tax-exempt organization," supra.

B. The Section 4958(b) Excise Tax

This additional tax equaling 200 percent of the excess benefit, is to be paid by a disqualified person who receives an excess benefit from an excess benefit transaction with an with an applicable tax-exempt organization who has not corrected the transaction within the taxable period. Like the section 4958(a)(1) tax, if more than one disqualified person is liable for the section 4958(b) tax, all such persons are jointly and severally liable for that tax.

"Correction"

Section 53.4958-1(c) defines correction as undoing the excess benefit to the extent possible, and taking any additional measures necessary to place the organization in a financial position not worse than that in which it would be if the disqualified person had not received the excess benefit. Additionally, where the excess benefit transaction arises from the payment of compensation for services under a contract that has not been completed, the terms of any ongoing compensation arrangement may need to be modified to avoid future excess benefit transactions.

"Taxable Period"

Section 53.4958-1(c) defines taxable period as beginning with the date on which the excess benefit transaction occurs and ending on the earlier of either the date of mailing a notice of deficiency under section 6212 with respect to the section 4958(a)(1) tax or the date on which the tax imposed by section 4958(a)(1) is assessed.

3. The Section 4958(a)(2) Excise Tax

This tax, equaling 10 percent of the excess benefit, is to be paid by an organization manager of an applicable tax-exempt organization who participates in an excess benefit transaction, knowing that it was such a transaction, unless the participation was not willful and was due to reasonable cause.

The maximum aggregate amount of tax collectible from organization managers with respect to any one excess benefit transaction is $10,000. If more than one organization manager is liable for the section 4958(a)(2) tax, all such persons are jointly and severally liable for that tax.

"Organization Manager"

Section 53.4958-1(d) defines organization manager as an officer, director, or trustee of any applicable tax-exempt organization, or any individual having powers or responsibilities similar to those of officers, directors, or trustees of the organization.

An officer of an organization may be specifically so designated under the certificate of incorporation, by-laws, or other constitutive documents of the organization, or may regularly exercise general authority to make administrative or policy decisions on behalf of the organization. Independent contractors, acting in a capacity as attorneys, accountants, and investment managers and advisors, are not officers. A person who has authority to recommend particular administrative or policy decisions, but not to implement them without approval of a superior, is not an officer.

An individual who is not an officer, director, or trustee, yet serves on a committee of the governing body of an applicable tax-exempt organization that invokes the rebuttable presumption of reasonableness based on the committee's actions, is an organization manager for purposes of the tax imposed by section 4958(a)(2).

"Participates"

Section 53.4958-1(d) defines participation as including the silence or inaction of an organization manager who is under a duty to speak or act, as well as any affirmative action by such manager. However, opposition to a transaction will not be considered participation.

"Knowing"

Section 53.4958-1(d) defines knowing as (1) actual knowledge of facts sufficient to identify the transaction as an excess benefit transaction, (2) awareness that the transaction may violate the provisions of federal tax law governing excess benefit transactions, and (3) either awareness that the transaction is an excess benefit transaction, or negligent failure to make reasonable attempts to ascertain whether the transaction is an excess benefit transaction.

Section 53.4958-1(d) defines participation as due to reasonable cause where the manager has exercised his responsibility on behalf of the organization with ordinary business care and prudence. An organization manager's reliance, after full disclosure of the factual situation, on the advice of legal counsel (including in-house counsel) expressed in a reasoned written legal opinion that a transaction is not an excess benefit transaction, will ordinarily not be considered knowing or willful and will ordinarily be considered due to reasonable cause, even if the transaction is subsequently held to be an excess benefit transaction. A written legal opinion is reasoned if it addresses itself to the facts and applicable law. The absence of advice of counsel shall not, by itself, give rise to any inference that a person participated knowingly, willfully, or without reasonable cause.

4. Revenue-Sharing Transactions

Whether a revenue-sharing transaction results in inurement and therefore constitutes an excess benefit transaction, depends upon all relevant facts and circumstances. If the economic benefit is provided as compensation for services, relevant facts and circumstances include, but are not limited to, the relationship between the size of the benefit provided and the quality and quantity of the services provided, as well as the ability of the party receiving the compensation to control the activities generating the revenues on which the compensation is based.

A revenue-sharing transaction may constitute an excess benefit transaction regardless of whether the economic benefit provided to the disqualified person exceeds the fair market value of the consideration provided if it permits a disqualified person to receive additional compensation without providing proportional benefits that contribute to the organization's accomplishment of its exempt purpose. The excess benefit shall consist of the entire economic benefit provided.

The revenue-sharing transaction rules apply to any such transaction that occurs on or after the date of publication of final regulations. In addition, any revenue-sharing transaction occurring after September 13, 1995, may constitute an excess benefit transaction if the economic benefit provided to the disqualified person exceeds the fair market value of the consideration provided in return. Before the date of publication of final regulations, however, the excess benefit shall consist only of that portion of the economic benefit that exceeds the fair market value of the consideration provided in return.

5. Loss of Tax-Exempt Status

The excise taxes imposed by section 4958 do not affect the substantive statutory standards for tax exemption under sections 501(c)(3) or (4). Organizations are described in those sections, for example, only if no part of their net earnings inure to the benefit of any private shareholder or individual.

10. HANDLING IRS AUDITS

A June 1998 GAO report, "Tax Administration: IRS Measures Could Provide a More Balanced Picture of Audit Results and Costs" (GGD-98-128), found that an IRS audit routinely takes at least a year to finish. Those who have experienced IRS audits of nonprofits may believe that the GAO figures are excessively low.

In 1999, the IRS procedures to determine the selection process by which organizations are targeted for audit came under focus. The IRS was sued for a politically motivated audit by the Western Journalism Center, host of www.worldnetdaily, the number one site on the Internet. In FOIA litigation, the IRS mysteriously lost many of the requested records, and a whistle-blower reported that documents were being shredded.

The first step to assisting a nonprofit being subjected to an audit is to obtain and file a signed Power of Attorney, Form 2848 (if there is not one relative to the tax year(s) under examination already on file at the IRS).

A site away from the audited organization (such as counsel's office) might be chosen. The availability of executive staff for interviews and answering questions by phone should be examined before dates for the audit are agreed upon. A visit to the nonprofit's headquarters office will need to be arranged, if desired by the IRS.

Normally, counsel would then thoroughly review potential issues with the nonprofit, including all documents identified in the IRS information/document request. It is important to determine both the focus and the impetus behind the audit. The closing letter of a prior audit is ordinarily the beginning point of any new audit. Likely objects of examination include:

Private inurement and private benefit: excessive compensation and leasing arrangements benefitting officers and directors, or too-lucrative contracts in favor of vendors or agents of the tax-exempt organization;

Informational (Form 990, Schedule A) and income tax returns;

Public Charity Status for section 501(c)(3) certain organizations;

Unrelated Business Income Tax (UBIT): income classified as unrelated to the tax-exempt purposes;

Employment tax returns (Form 941); Form W-2 and Form 1099; and

Disclosure and Examination of Exempt Organization Return.

Document requests and interrogatories should be examined to ensure that they reflect the time period under audit.

The IRS publishes various handbooks for use by its agents. A valuable resource when responding to an audit is the Exempt Organizations Handbook, which is available to the public (e.g., CCH's Exempt Organizations Reporter).

1. IRC § 162(e)(5)(B)(ii) defines such in-house expenditures as: expenditures for influencing legislation or a direct communication with a covered executive branch official in an attempt to influence the official actions or positions of such official, that are not either (1) payments to a person engaged in the trade or business of such activities, or (2) dues or similar amounts paid or incurred which are allocable to such activities.